In November 2019, the securities and exchange commission (SEC) revoked the licenses of 53 fund management companies in pursuant to Section 122 (2) of the Securities Industry Act, 2016 (Act 929). SEC’s announcement attributed the revocation of the licenses to the failure of these fund management companies to return clients funds.
As a professional who lived and observed events as they unfolded, I think I owe the system a great obligation to pen down my observations of the events that triggered the crises and opportunities thereafter. This article provides a comprehensive overview of the events that led to the crises and the opportunities thereafter for asset management firms to generate alpha.
Understanding the Business Model of Fund Management Companies in Ghana
The crises can be properly understood by dissecting the business model of fund management firms in Ghana. The revenues from fund management companies in Ghana emanate from three main business lines namely:
a. Managed Funds: Funds under this revenue line are managed by the company on behalf of clients. They’re discretionary in nature and provide the best of margins. Clients for these products in the past had been corporations, High Net Worth Individuals, non-registered pension schemes, rural banks, Savings & Loans and credit unions. Funds managed under this business line contributed the biggest to the industry’s crises.
b. Collective investment schemes: Funds under this revenue line are mainly from retail investors and managed as mutual funds or unit trust schemes. Revenue margins range from 1% to 2.5% of assets under management and tenors are not fixed. Collective investment schemes that were managed with custodian accounts were the safest due to controls and checks from third party custodians.
c. Pensions: As the name implies, these are funds managed on behalf of pension trustees and offer the lowest profit margins (fee is priced at 0.54%). It was also the most regulated revenue segment and therefore the least affected in the crises.
The Genesis of the crises:
Regulatory opening provides opportunity for Managed funds:
Prior to 2018, rural banks, micro-finance companies and savings & loans firms were allowed to accept placement certificate from fund management companies as investment securities. These investment certificates were afforded the same zero risk weighting as Government treasuries even though they carried enormous amount of credit risk. So, for example, a fund management company AA could accept investment funds from a rural bank and issue out certificate to rural bank BB which then qualifies as investments securities for regulatory reporting. This fine regulatory opening or lapse also enabled most state-owned enterprises to place their surplus funds through fund management companies for investment certificates without any red flag from their auditors. In addition, the introduction of private fund managers into the domestic pension arena further accelerated the crave for fund management license.
In response to these new opportunities, several asset management firms sprung-up to offer institutional fund management services to their new clients and markets. Data from SEC’s annual report indicates that between 2007 and 2017 the number of asset management firms operating in Ghana increased from 86 firms to 122 firms, representing a 41% rise. The increase in asset management firms and thin industry margins fueled an atmosphere of unethical competition. Soon their clients (Rural Banks, Credit Unions and S&L companies) began demanding for higher yields above treasury instruments to shore-up their reported profits in an era where government bills offered approximately 22% to 24% return per annum. Returns above 30% became the new normal to be in business.
Micro-finance to the rescue:
The success of professor Mohammed Yunus’s microfinance experiment in Bangladesh with Grameen Bank which went on to disabuse the world’s preconceived perception about microfinance and later on secured him a noble peace prize in 2006 meant that central banks in developing countries were now receptive to the idea of micro-financing. In Ghana however, Microfinance companies rather stepped in as investment vehicles for fund management companies. They provided the much-needed returns for these Asset management Companies to keep on satisfying their clients incessant quest for higher yields and profitability.
Typically, a micro-finance company will charge a fee of about 5%-6% per month on loans disbursed to its clients. This amounted to a yield of approximately 60% to 72% per annum assuming no default or write-off. Due to this impressive operational profit margins most of the mobilized funds from the credit unions & rural banks ended up in the vaults of microfinance companies in search of yields around 35%.
Cost of Capital for MFCs
Considering that the profit margins from Micro-finance companies were impressive than the 2%-3% per annum profit margins from Asset Management Companies, it didn’t take long before some asset management companies started setting-up their own microfinance companies to enjoy bigger spreads and further consolidate their business. But one thing was missing, Clients!!!!!
The microfinance clientele base was small and could hardly pay for their high interest loans without defaulting. Soon the books of these micro-finance companies were mauled with high non-performing loans.
Micro-finance Companies Diverted into Real Estate to sustain Loan Write-off and Competition for Yield
With high NPLs and shrinking clientele, these micro-finance companies and some asset management firms decided to engage in real estate business where the promise of a higher return was guaranteed. Unfortunately, most of the funds they mobilized were short-tenored funds with maximum of 6-months. So now short-term funds began flowing into long-term projects, creating a funding mismatch. To solve this problem, Micro-finance companies decided to pay business development fees to their fund managers, to convince them in rolling over their funds on maturity till they have adequate liquidity to pay off funds. This business development then became the new normal.
The Beginning of the End; Dream Finance, Dwadifo, CIG, DKM and Noble Dream gave a shocking and lasting blow to the industry;
As revenues from their real estate projects failed to materialize, some Micro-finance companies began experiencing serious cashflow challenges that rendered them technically bankrupt. Notable amongst them was Dream Finance, Dwadifo, CIG and Noble Dream. These micro-finance companies went bankrupt and created deep cracks or holes in the balance sheets of asset management companies. These funds were simply gone never to return and considering that all these investments were unsecured made their recovery process more arduous.
The demise of these Micro-finance companies gave an unexpected blow to the asset management industry which necessitated several rapid and unconventional interventional measures from shareholders. For asset management firms that were subsidiaries of Banks, the Banks step in and provided liquidity whiles those that had no mother companies increased their returns astronomically to entice new deposits and discourage withdrawals.
Soon by 2018 we had almost 53 asset management and 347 micro-finance companies that were insolvent and unable to pay off depositors’ funds. The number would have been worst had Government not intervened to pay customers of defunct financial services companies their locked-up deposits in 2018 which benefitted most asset management companies.
Too much sugar can kill: Chasing yields meant that people ignored the risk inherent in their investment decisions and placement houses. High returns meant high risk therefore instead of chasing high returns rather chase competitive returns.
Business development can lead to unethical practices: it is undoubted that the business development fees paid to some fund managers clouded their sense of judgement and perception of risk. Always seek your employer’s written consent before accepting any BD from clients.
Don’t Underestimate Research: Research plays a very important role in mitigating credit risk and industry lifecycles. During the period of the crises, the few asset management companies that emphasized a lot on credit assessment and profiling of placement houses happened to be the least affected in the crises. Asset management firms should invest in research departments to assist them to measure credit risk.
The part two of the article will cover the opportunities in the industry and how fund managers can capitalize on evolving trends to generate alpha for clients. Also, the article will open up identified areas of risk worth tracking to ensure a resilient asset management industry.
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